DCIT, BANGALORE vs. M/S TELELOGIC INDIA PRIVATE LIMITED, BANGALORE

Per INTURI RAMA RAO, AM : These are cross appeals by the assessee-company as well as revenue and are directed against the order of the ld.CIT(Appeals)-IV, Bangalore, dated 08/11/2011 for the assessment year 2005-06.

3. The assessee raised the following grounds of appeal: “The grounds stated here under are independent of, and without prejudice to one another:

1. Assessment and reference to Transfer Pricing Officer (`TP0') are bad in law a) The assessment order passed by the ACIT under section 143(3) of the Income-tax Act, 1961 ('the Act') and the order passed by the Commissioner of Income-tax (Appeals)-IV, ('the CIT(A)') under section 250 of the Act, are bad on facts and in law, and is in violation of principles of natural justice. b) The CIT(A) erred in law in not appreciating the meaning of the erstwhile phrase 'having IT(TP)A No.22 & 30/B/2012 Page 3 of 21 regard to' in sections 92 and 92CA(4) of the Act. c) The CIT(A) erred in law in confirming that the amendment made to section 92CA(4) ride the Finance Act, 2007 was to set right the lacuna in the said section.

2. The fresh comparable search undertaken by the TPO is bad in law a) The CIT(A) erred in determining a transfer pricing adjustment to Information Technology (`IT') Enabled services, by substituting the TPO's arm's length price and not that determined by the Appellant. b) The C1T(A) erred in rejecting the value of international transaction as recorded in the books of account, as the arm's length price. c) The CIT(A) erred in law in holding that the fresh comparability analysis using non-contemporaneous data conducted by the TPO and further substituting the Appellant's analysis with fresh benchmarking analysis by the TPO on his own conjectures and surmises. Thus, the Appellant prays that the fresh benchmarking analysis conducted by the TPO is liable to be quashed. d) The TPO erred in not sharing the fresh comparability analysis conducted by him at the time of assessment and the CIT(A) erred in not commenting on the same in the order. e) On the facts and in the circumstances of the case and in law, the TPO erred and the CIT(A) further erred in not demonstrating that the motive of the Appellant was to shift profits outside of India by manipulating the prices charged in its international transaction which is a pre-requisite condition to make any adjustment under the provision of Chapter X of the Act.

3. Comparability analysis adopted by the TPO for determination of arm's length price a) The AO/TPO grossly erred on facts and the CIT(A) further erred in confirming the benchmarking of IT enabled services of the Appellant with companies operating as full-fledged entrepreneurs without IT(TP)A No.22 & 30/B/2012 Page 4 of 21 considering the differences in the functions performed, assets employed and risk undertaken by the Appellant vis-a-vis comparable companies. b) The TPO erred on facts in applying arbitrary filters to arrive at a fresh set of companies as comparables to the Appellant, without establishing functional comparability. c) The CIT(A) erred in facts in confirming the comparability analysis conducted by the TPO, without analysing the functional and risk profile of Appellant vis-à-vis comparables selected in the Transfer Pricing Order. d) The AO/TPO erred on facts in rejecting most of the comparable companies arrived at in the Transfer Pricing Study.

4. Erroneous data used by the AO/TPO a) The AO/TPO has erred in law and the CIT(A) further erred in confirming the use of data, which was not contemporaneous and which was not available in the public domain at the time of conducting the transfer pricing study by the Appellant. b) The AO/TPO erred in law and the CIT(A) further erred in not applying multiple-year data while computing the margin of alleged comparable companies.

5. Non-allowance of appropriate adjustments to the comparable companies, by the A0/TPO a) The AGTPO erred in law and on facts in not allowing appropriate adjustments under Rule 10B to account for, inter alia, differences in (a) accounting practices, (b) marketing expenditure, (c) research and development expenditure and (d) risk profile between the Appellant and the comparable companies. b) The AO/TPO erred in law and on facts in not allowing appropriate adjustment for the specific non-operating costs incurred by the Appellant (during FY 2004-05. 6 Interest levied under section 234B of the Act The CIT (A) has erred in confirming consequential interest under section 2348 of the Act amounting to Rs 394,163.

IT(TP)A No.22 & 30/B/2012 Page 5 of 21 7 Interest under section 234D The CIT (A) has erred in confirming, interest under section 234D of the Act amounting to Rs. 383,684. 8 Initiation of Penalty Proceedings The learned CIT (A) has erred in confirming the initiation of penalty proceedings under section 271(1)(c) of the Act. 9 Relief a) The Appellant prays that directions be given to grant all such relief arising from the above grounds and also all relief consequential thereto. b) The Appellant craves leave to add to or alter, by deletion, substitution or otherwise, the above grounds of appeal, at any time before or during the hearing of the appeal. c) Further, the Appellant prays that the adjustment in relation to Transfer Pricing matters made by the AO/TPO and upheld by the CIT(A) is bad in law and is liable to be deleted.

4.1 The assessee-company had the following four segments.

IT(TP)A No.22 & 30/B/2012 Page 6 of 21 Descrption/Amount Product Sales Software GSB & Tele in Rs. development Marekting Operating Revenues 8,36,22,887 73,11,315 3,91,21,016 Operating Expenses 8,13,86,739 1,15,83,999 4,28,95,765 Operating Profit 22,36,148 (-)42,72,684 (-)37,74,749 Operating Profit on 2.67% on sales (-) 3.69% on (-) 8.80% on Cost/Sales cost cost 4.2 Return of income for the assessment year 2005-06 was filed declaring loss of Rs.28,53,770/- on 28/10/2005. The assessee-company also reported the following international transactions: i) Payment of royalties Rs.2,35,87,653/- ii) Training and consultancy Rs. 5,08,342/- iii) Global Support Services Rs.3,06,54,204/- iv) Telemarketing Rs. 84,66,812/- v) Software Development Rs. 73,11,315/- vi) Reimbursement of expenses Rs. 16,60,433/- 4.3 The assessee-company sought to justify consideration received for the international transactions entered with its AE to be at arm’s length price [ALP]. The assessee-company had also submitted transfer pricing study report adopting the operating profit on cost (OP/TC) as a profit level indicator for the transfer pricing study. The assessee-company applied Transactional Net Margin Method [TNMM] which was considered to be the most appropriate method for purposes of bench marking the international transactions. The assessee- company’s profit margin was computed at 8.82% and the assessee-company claimed that the same was comparable with IT(TP)A No.22 & 30/B/2012 Page 7 of 21 other companies rendering the IT Enabled Services (ITES). For the purpose of transfer pricing study, the company had chosen 9 comparable entities and arithmetic average of operating profit margins of said comparables was computed at 7.46%. According to the assessee-company, its PLI was within the acceptable range as indicated under second proviso to sec.92C. The assessee-company had chosen the following 9 entities as comparables whose average profit margin was computed at 7.46%.

Sl. Company Name Margin as No. taken by taxpayer 1. Ace Software Exports Ltd. 14.66% 2. Fortune Infotech Ltd. 15.10% 3. Genesys International Corp Ltd. -2.06% 4. Intelnet Global Services Ltd. -5.01% 5. Netvista Information Solutions Ltd. 12.94% 6. Northgate BPO Services Ltd. 17.71% 7. Online Media Solutions Ltd. 4.71% 8. Ontrack Systems Ltd. 4.44% 9. R T Outsourcing Services Ltd. 4.44% Arithmetic Mean 7.46% The assessee-company computed its operating margin excluding extra-ordinary expenses to the extent of Rs.70,47,361/-.

IT(TP)A No.22 & 30/B/2012 Page 8 of 21 development services and reimbursement of expenses were considered to be at arm’s length by the TPO. The support services and telemarketing services have been merged by the assessee-company and the TPO for the purpose of TP analysis. The TPO accepted the TNMM adopted by the assessee-company but rejected the transfer pricing study report. The TPO proceeded to identify a different set of comparable entities for the purpose of determining the ALP. While doing so, the ld. TPO had applied the following filters: a. Companies whose turnover while doing so, <Rs.1 crore were excluded. b. Companies who have less than 25% of their revenues as export sales were excluded. c. Companies who have more than 25% related party transactions of the sales were excluded. d. Companies who have diminishing revenues/ persistent losses for the period under consideration were excluded. e. Companies having different financial year ending (i.e. not March 31, 2006) or date of the company not available for the 12 month period i.e. 01/04/2005 to 31/03/2006 were excluded.

5.1 The TPO finally selected the following comparables:

Sl. Company Name Operating Adj. No. margin on Margin cost 1 Allsec Technologies Ltd. 29.85 26.81% 2 Safron Global Ltd. 24.88 20.61% 3 Vishal Information Tech Ltd 45.62 36.75% 4 Cosmic Global Ltd (Tulsyan Tech 17.02 12.55% Ltd. 5 Transworks Information Services 2.81 0.02% Ltd. 6 Wipro BPO Solution Ltd. 18.59 15.51% 7 Ace Software Exports Ltd. 14.5 11.75% 8 Nucleus Netsoft & GIS Ltd. 40.06 37.02%

IT(TP)A No.22 & 30/B/2012 Page 9 of 21 9 Maple E-solutions Ltd. 28.75 24.11% Average 24.68 20.57% 5.2 The TPO computed average profit margin of the comparables finally selected at 24.68%. The TPO had allowed the adjustment on account of working capital to the extent of 4.11%. On the above said basis, the TPO computed the transfer pricing adjustment as follows:

Arms length mean margin 24.68% Less: working capital adjustment 4.11% Adjusted mean margin after working 20.57% capital adjustment Operating cost Rs.5,17,19,424/- Arms’ length price – 120.57% of Rs.5,17,19,424/- operating cost Total operating revenue … Rs. 3,91,21,016/- Shortfall being adjustment u/s 92CA … Rs.1,25,98,408/- The AO passed an order u/s 143(3) dated 28/11/2008 incorporating the above adjustment u/s 92CA.

IT(TP)A No.22 & 30/B/2012 Page 10 of 21 less than Rs.1 crore. As regards the filter of the related party transactions, the ld.CIT(A) held that only comparables with no related party transactions alone should be considered. He, accordingly, directed the TPO to exclude from list of comparables M/s.Allsec Technologies Ltd., Transworks Information Service Ltd., Wipro BPO solutions Ltd., and ACE Software Export Ltd.

6.1 As regards the comparable Intelnet Global Services Ltd., the contention of the TPO that only the current year data alone is used, is accepted and this comparable is rejected as multiple year data is used. On the same reasoning, even the comparability of Netvista Information Solutions Ltd., was rejected. The comparables viz. Online Media Solutions Ltd., and R T Outsourcing Services Ltd., were also rejected by the ld.CIT(A) as the foreign exchange earnings does not exceed 25% of the total revenue.

6.2 As regards the comparables selected by the TPO, the ld.CIT(A) rejected the Maple e-Solutions on the ground that the operations are available only for a period of 4 months and it does not pass through the filters applied by the TPO. As regards Nucleus Netsoft Technologies Ltd., it was rejected by the ld.CIT(A) on the ground that no segmental data was available. In respect of Vishal Information Technolgies Ltd., this company was retained by the ld.CIT(A) holding that it does

IT(TP)A No.22 & 30/B/2012 Page 11 of 21 not make a difference whether the payment is made in the name of salary or data entry charges and also relied on the decision of co-ordinate bench (Hyderabad) in the case of M/s.Deloitte Consulting India Pvt. Ltd. In & 1084/Hyd/2010. As regards Saffron Global Ltd., it was retained by the ld.CIT(A) rejecting the contention of the assessee-company that the financial data is not available on the public domain at the time of TP study. After the directions of the ld.CIT(A) the surviving comparables are only three viz.,Saffron Global Ltd., Vishal Information Tech.Ltd., and Cosmic Global Ltd., whose average operating margin worked out to 29.18%. The ld.CIT(A) further held that the gains or loss arising out of foreign exchange transactions are purely in the nature of operating revenue. The ld.CIT(A) rejected the claim of the assessee-company for adjustment on account of differences in accounting policies, marketing expenditure and risk adjustment. The ld.CIT(A) also rejected the claim for adjustment of extra-ordinary expenses incurred should be excluded from operating cost.

IT(TP)A No.22 & 30/B/2012 Page 13 of 21 8.1 On the other hand, ld.DR submitted that that this comparable has passed through all the filters adopted by the TPO and therefore, should be included in the list of comparables.

8.2 We heard the rival submissions and perused material on record. This comparable is selected by the TPO. The assessee-company objected for inclusion of this company on the ground that the business model is different as it outsourced major portion of the work and the employees cost is merely 0.9% of the revenue and showing abnormal profit of 45.62%. The ld.CIT(A) had not concurred with the views of the assessee-company and therefore, confirmed the action of the TPO in including this company in the list of comparables. The Mumbai bench of Tribunal in the case of ACIT vs. Maersk Global Service Center (India) P Ltd. (133 ITD 543)(Mum) held that this company cannot be considered as a comparable as it outsourced major portion of the business. This decision was subsequently followed by the same bench in the case of ACIT vs. Hapag Lloyd Global Services Pvt. Ltd. (TS-47-ITAT- 2013)(Mum); Nomura Fin Services (India) (P.) Ltd. Vs. ACIT (2013) 33 taxmann.com 4 (Mum-Trib); Hyderabad Bench in the cases of Brigade Global Services vs. ITO 33 taxmann.618(Hyd-Trib) and Capital IQ Information Systems (India) P.Ltd. vs. DCIT (25 ITR (Trib) 185)(Hyd) and Bangalore bench of Tribunal in the case of ITO vs. Netlinx India Pvt. Ltd.

IT(TP)A No.22 & 30/B/2012 Page 14 of 21 (TS-722-ITAT-2012(Bang). This comparable has been considered by the Hon’ble Delhi High Court in the case of Rampgreen Solutions P. Ltd. Vs. CIT (377 ITR 533) wherein the Hon’ble High Court, after considering the decisions of the Tribunal cited supra, held that this company cannot be considered as a comparable with ITeS company as it is engaged in the Knowledge Process Outsourcing Service. It was further held that the business model of this company was different and therefore cannot be considered as a comparable with ITeS company. The relevant paragraphs viz. 37 & 38 are reproduced hereunder:

“37. Applying the aforesaid principles to the facts of the present case, it is once again clear that both Vishal and eClerx could not be taken as comparables for determining the arm's length price. Vishal and eClerx, both are into knowledge process outsourcing services. In Maersk Global Centers (India) Pvt. Ltd. (supra), the Special Bench of the Tribunal had noted that eClerx is engaged in data analytics, data processing services, pricing analytics, bundling optimisation, content operation, sales and marketing support, product data management, revenue management. In addition, eClerx also offered financial services such as real-time capital markets, middle and back-office support, portfolio risk management services and various critical data management services. Clearly, the aforesaid services are not comparable with the services rendered by the assessee. Further, the functions undertaken (i.e., the activities performed) are also not comparable with the assessee. In our view, the Tribunal erred in holding that the functions performed by the assessee were broadly similar to that of eClerx or Vishal. The operating margin of eClerx, thus, could not be included to arrive at an arm's length price of controlled transactions, which were materially different in its content and value. In Maersk Global Centers (India) Pvt. Ltd. (supra), the Special Bench IT(TP)A No.22 & 30/B/2012 Page 15 of 21 of the Tribunal had noted the same and had, thus, excluded eClerx as a comparable. It is further observed that the comparability of eClerx had also been examined by the Hyderabad Bench of the Tribunal in Capital Iq Information Systems (India) (P.) Ltd. v. Addl. CIT (supra), wherein the Tribunal directed the exclusion of eClerx as a comparable for the reason that it was engaged in providing knowledge process outsourcing services and further that it had also returned supernormal profits.

8.3 Respectfully following the decision of the Hon’ble High Court and co-ordinate benches of Tribunal, we hold that Vishal Information Technologies cannot be considered as a comparable with the assessee-company. Hence, we direct the AO/TPO to exclude this company from the list of comparables for the purpose of bench marking the international transactions with its AE.

IT(TP)A No.22 & 30/B/2012 Page 16 of 21 9. Saffron Global Ltd.: This comparable company was chosen by the TPO. The assessee-company objected for inclusion of this company in the list of comparables on the ground that the financial data for the financial year 2004-05 was not available at the time of TP study. The ld.CIT(A) held that this company can be considered as comparable in view of the functional similarity and rejected the contention of the assessee-company that it cannot be considered as a comparable as data was not available at the time of TP study. The learned AR for assessee-company submitted that there was abnormal increase of 93% in turnover indicating peculiar economic circumstances. He drawn our attention to annual report wherein it is mentioned that internal controls of the company needs to be improved, as there was a proposal of merger with Triton Corporation and the accumulated losses were greater than 50% of net worth. In the circumstances, it is submitted that this company cannot be compared as a comparable with the assessee-company.

9.1 On the other hand, ld.DR supported the orders of the lower authorities and submitted that when there is a functional comparability, the company should be considered as comparable.

9.2 We heard the rival submissions and perused material on record. The fact that there was a proposal for merger of this IT(TP)A No.22 & 30/B/2012 Page 17 of 21 company with Triton Corporation and the accumulated losses are more than 50% of net worth, the internal controls require to be improved and increase in turnover is not a relevant factor for excluding this company as a comparable. These factors have no impact either on the comparability or profitability of the current year and therefore, we uphold the findings of the ld.CIT(A) and this ground of appeal filed by the assessee- company is dismissed.

12.1 Ld.CIT-DR submitted that it is fairly settled law that the companies having RPT less than 15% can be considered as comparable. The learned AR of the assessee-company fairly conceded for this submission. However, he objected for IT(TP)A No.22 & 30/B/2012 Page 18 of 21 inclusion of Wipro BPO as a comparable in view of high turnover and having huge intangibles etc.

12.2 We heard rival submissions and perused material on record. The provisions of Section 92 provides that income arising from international transaction is to be computed having regard to ALP. Section 92F(ii) defines “arm’s length price” to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. To compute ALP the results of the international transaction are bench marked against comparable uncontrolled transaction. The mandate of s. 92F(ii) is that ALP shall be computed considering price applied or proposed to be applied in transactions between non- AE’s.

12.2 When selection of external comparables, one needs to ensure that such external comparables are uncontrolled. The companies having controlled transactions therefore needs to be eliminated. Then the issue that crops up is what should be the related party transaction ratio for excluding as comparable. This issue had come up before the Tribunal in numerous cases. The Delhi Coordinate Bench in the case of M/s Sony India Pvt. Ltd. Vs. DCIT [2008] 114 ITD 448 (Del), held that the companies having relating party transactions of not exceeding 15% can be taken as a comparable. This ratio was followed by IT(TP)A No.22 & 30/B/2012 Page 19 of 21 the Coordinate Benches of the Tribunal in the following decisions: i. Customer.Com Pvt. Ltd. Vs. DCIT, [2012] 28 taxmann.com 258 (Bang.): [2013] 140 ITD 344 (Bang.) : [2013] 21 ITR (Trib.) 514 (Bang.) ii. ITO Vs. CRM Services India (P.) Ltd. [2011] 14 taxmann.com 96 (Del): [2011] 48 SOT 41 (Del) (URO). iii. CSR India (P) Ltd. Vs. ITO [2013] 31 taxmann.com 265 (Bang.) iv. Logica Pvt. Ltd. Vs. ACIT, IT(TP)A No. 1129/Bang/2011: TS-131-ITAT-2013-BANG-TP. Avaya India (P.) Ltd. Vs ACIT [2013] 33 taxmann.com v. 569 (Del-Trib.) : [2012] 15 ITR (T) 237 (Del-Trib.) vi. ACIT Vs. Sakata Inx. (India) Ltd. [2012] 21 taxmann.com 37 (JP.) :[2012] 53 SOT 165 (JP.) vii. Huawei Tehnologies India Pvt. Ltd. Vs. ITO, IT(TP) No. 1338/Bang/2010. Wills Processing Services (India) (P.) Ltd. vs. DCIT, TS- viii. 49-OITAT-2013 (Mum.)-TP 12.3. Thus, the law is fairly well settled to the extent that the companies having in related party transactions more than 15% cannot be considered as comparable. Accordingly, we are of the opinion that the ld.CIT(A) was not justified in holding that only the companies having no RPT should alone be considered. Therefore, we hold that Allsec Technologies, Transworks Information and Ace Software can be considered as comparable. However, Wipro BPO cannot be considered as a comparable on account of fact that it is substantial intangibles and enjoying huge goodwill. This comparable was considered by the co-ordinate bench in the case of DCIT vs. M/s.Akamai

IT(TP)A No.22 & 30/B/2012 Page 20 of 21 Technologies India Pvt.Ltd in IT(TP)A No.879/Bang/2013 wherein it has been held as follows: “10.1 We heard the rival submissions and perused the material on record. The Hon’ble Bombay High Court in the case of CIT vs.Pentair Water India Pvt. Ltd. (381 ITR 216) had held that the turnover was a relevant factor for the purpose of comparability of two entities. However, without going into this issue, as rightly submitted by the learned AR of the respondent-assessee-company, it was held by the co-ordinate benches of Hyderabad and Mumbai benches in the cases cited supra, Wipro BPO Solutions Ltd., cannot be considered as a comparable entity in view of the fact that it is gigantic company owning intangibles and having substantial brand value. Co-ordinate bench (Hyderabad) of the Tribunal, in the case of M/s.Market Tools Research Pvt.Ltd., (supra) held as follows: “20. It is a fact that WIPRO BPO is a big company owning intangibles and having substantial brand value. It had generated considerable goodwill, reputation and brand value in the market. It is also a fact that it earns substantial revenue from products which are sold at a premium unlike the assessee which is only a contract service provider to its AE. Another relevant factor which cannot be lost sight of is, as can be seen from para 14.5 of his order, the TPO applying the turnover filter has excluded companies having turnover from ITES at less than 1 crore. Applying the same logic he should also have excluded companies having extraordinarily high turnover. While the assessee's turnover is about 5 crores, turnover of WIPRO BPO is 617.71 crores i.e almost 120 times more. Considering the aforesaid facts we are of the view that WIPRO BPO cannot be considered to be a comparable to the assessee.”

10.2 In the case of Maersk Global Services Centre (India) P. Ltd.(supra), Mumbai bench of the Tribunal held that: “Insofar as WIPRO BPO Solutions Limited is concerned, we find that their turnover is eleven times greater than that of the assessee. This IT(TP)A No.22 & 30/B/2012 Page 21 of 21 company having such a higher brand value along with much higher turnover, in our considered opinion, has been rightly excluded by the ld.CIT(A).” Therefore respectfully following the decisions of the co-ordinate benches of Tribunal in the cases cited supra, we hold that WIPRO BPO Solutions cannot be considered as a comparable entity, and the findings of the ld.CIT(A) are upheld accordingly. The ground of appeal of the revenue is dismissed.” Therefore, in the light of the above settled legal position, we hold that Wipro BPO cannot be considered as a comparable.